We Wouldn't Be Too Quick To Buy Smith & Nephew plc (LON:SN.) Before It Goes Ex-Dividend

Smith & Nephew plc (LON:SN.) is about to trade ex-dividend in the next 3 days. The ex-dividend date is usually set to be two business days before the record date, which is the cut-off date on which you must be present on the company's books as a shareholder in order to receive the dividend. The ex-dividend date is of consequence because whenever a stock is bought or sold, the trade can take two business days or more to settle. This means that investors who purchase Smith & Nephew's shares on or after the 27th of March will not receive the dividend, which will be paid on the 28th of May.

The company's upcoming dividend is US$0.231 a share, following on from the last 12 months, when the company distributed a total of US$0.38 per share to shareholders. Last year's total dividend payments show that Smith & Nephew has a trailing yield of 2.7% on the current share price of UK£10.85. Dividends are a major contributor to investment returns for long term holders, but only if the dividend continues to be paid. So we need to check whether the dividend payments are covered, and if earnings are growing.

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Dividends are usually paid out of company profits, so if a company pays out more than it earned then its dividend is usually at greater risk of being cut. It paid out 79% of its earnings as dividends last year, which is not unreasonable, but limits reinvestment in the business and leaves the dividend vulnerable to a business downturn. We'd be concerned if earnings began to decline. That said, even highly profitable companies sometimes might not generate enough cash to pay the dividend, which is why we should always check if the dividend is covered by cash flow. It paid out more than half (54%) of its free cash flow in the past year, which is within an average range for most companies.

It's encouraging to see that the dividend is covered by both profit and cash flow. This generally suggests the dividend is sustainable, as long as earnings don't drop precipitously.

See our latest analysis for Smith & Nephew

Click here to see the company's payout ratio, plus analyst estimates of its future dividends.

Have Earnings And Dividends Been Growing?

Companies with falling earnings are riskier for dividend shareholders. If earnings decline and the company is forced to cut its dividend, investors could watch the value of their investment go up in smoke. Readers will understand then, why we're concerned to see Smith & Nephew's earnings per share have dropped 7.2% a year over the past five years. Ultimately, when earnings per share decline, the size of the pie from which dividends can be paid, shrinks.

Another key way to measure a company's dividend prospects is by measuring its historical rate of dividend growth. Since the start of our data, 10 years ago, Smith & Nephew has lifted its dividend by approximately 2.4% a year on average. The only way to pay higher dividends when earnings are shrinking is either to pay out a larger percentage of profits, spend cash from the balance sheet, or borrow the money. Smith & Nephew is already paying out a high percentage of its income, so without earnings growth, we're doubtful of whether this dividend will grow much in the future.

Final Takeaway

Has Smith & Nephew got what it takes to maintain its dividend payments? It's never good to see earnings per share shrinking, but at least the dividend payout ratios appear reasonable. We're aware though that if earnings continue to decline, the dividend could be at risk. It's not an attractive combination from a dividend perspective, and we're inclined to pass on this one for the time being.

Although, if you're still interested in Smith & Nephew and want to know more, you'll find it very useful to know what risks this stock faces. Every company has risks, and we've spotted 2 warning signs for Smith & Nephew you should know about.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.